The Internet, a growing network of networks, is an often touted and often misunderstood
technology. It has its own infrastructure complete with service providers, private networks, user
communities, international links, etc. similar to telephone or telegraph industries. However, the
Internet is more decentralized and less application-specific than traditional telecommunication
industries. These differences extend beyond the technology of the Internet to the economics and
policies.
This paper explores Internet economics, a growing field which encompasses the technology,
economics, and policy surrounding the Internet. It identifies different communities who have
overlapping interests in this field and how their preconceived notions of how the Internet operates
create contradictory views on how this technology will continue to evolve in a self-sustaining
manner. Specifically, it explores the issue of usage sensitive pricing versus flat-fee pricing as
applied to the Internet. It provides anecdotal evidence to support general views communities
have towards pricing issues. It identifies roadblocks to implement usage sensitive pricing on the
Internet. It describes short-term projects that will provide better data to enable a better
understanding of the issues

Bailey, Joseph P.

DSpace@MIT

Internet EconomicsJoseph P. Bailey1Working PaperFebruary 3, 1995 Draft[Please do not cite or distribute without consent of the author]                                              1The author is affiliated with the Research Program on Communications Policy at the MassachusettsInstitute of Technology and can be reached by email, bailey@far.mit.edu, or by phone, 617/253-6828.The author wishes to thank NASA and NSF for funding and administrative support for thisresearch.  In particular, Scott Behnke, David Brown, Thomas Lee, Tony Villasenor, Walter Wiebe andSteve Wolff helped greatly with the formulation of this paper.AbstractThe Internet, a growing network of networks, is an often touted and often misunderstoodtechnology.  It has its own infrastructure complete with service providers, private networks, usercommunities, international links, etc. similar to telephone or telegraph industries.  However, theInternet is more decentralized and less application-specific than traditional telecommunicationindustries.  These differences extend beyond the technology of the Internet to the economics andpolicies.This paper explores Internet economics, a growing field which encompasses the technology,economics, and policy surrounding the Internet.  It identifies different communities who haveoverlapping interests in this field and how their preconceived notions of how the Internet operatescreate contradictory views on how this technology will continue to evolve in a self-sustainingmanner.  Specifically, it explores the issue of usage sensitive pricing versus flat-fee pricing asapplied to the Internet.  It provides anecdotal evidence to support general views communitieshave towards pricing issues.  It identifies roadblocks to implement usage sensitive pricing on theInternet.  It describes short-term projects that will provide better data to enable a betterunderstanding of the issues.[T]he expected increase in video and audio applications suggests that pricing asa mechanism for rationing access to infrastructure will become more generallyneeded over time. -- "Realizing the Information Future", NRC, 1994, p. 8.IntroductionUnderstanding the Internet as an economic system is difficult to do because of its almost anarchicform.  Unlike the phone system which developed as a single network to provide one service(voice), the Internet is home to many applications and networks.  Also unlike the phone system,the Internet has no billing infrastructure in place.  Instead of users getting charged after they usethe service on a usage-sensitive basis, they are charged a flat fee for some kind of connect charge.Also, because of the aggregation of users at a local site, the flat fee is usually charged at a muchhigher level than the user level.2However, the flat fee model may not work as the Internet grows.  While Internet traffic isgrowing around 20% per month, new networks are growing about 7% per month.3  Thistranslates into more traffic generated by the same number of users.  The traditional way toaccommodate this network growth is to increase capacity and charge it back to the users.However, since usage is increasing faster than the number of users, the current flat fee will haveto increase even though the quality of service doesn’t necessarily increase.4  What is n cessary isan Internet cost recovery system which is equitable for the users.  While some have suggested                                              2This is largely due to the technology which doesn’t distinguish network traffic to the different users.While Internet Protocol (IP) packets do have information that distinguishes where the come from (the IPsource address) this information isn’t used at the network routers which only look at the destination IPaddress to increase throughput and keep costs lower.3A. Rutkowski, presentation to the Japanese Internet Society (ISOC), July 1994.  Seehttp://www.isoc.org/interop-tokyo.html.4For example, a person who only uses the Internet for email will have to absorb some of the increase inprice even though email usage doesn’t lead to wide area networking investments.  It is multimediaapplications like CU-SeeMe and NCSA Mosaic that lead to these investments.usage sensitive billing as such a mechanism it is unclear whether or not usage-sensitive billing ispossible with the current technology.5  Even if it is, usage sensitive billing will undoubtedlydiscourage use of the Internet which goes against the research and educational goals of theNational Research and Educational Network (NREN).6Is the Internet Broken?The Internet, as a system, is viewed very differently by different user communities.  Three mainuser communities are acknowledged here and they each answer the question “is the Internetbroken?” differently.  Figure 1 shows a Venn diagram of these user communities.  Although thesecommunities are mostly separate and some people/organizations operate where there is overlap,there is no common answer for all of these communities.  It is this area (denoted by a “*” inFigure 1) where we need to find common ground and an understanding of Internet economics.Figure 1*Engineering GovernmentEconomicsThis paper hopes to outline the views of the three communities in Figure 1 and outlines the workdone in this area.                                              5MacKie-Mason (1994) has suggested usage-sensitive billing.  Bohn (1994) suggests a less sensitivebilling scheme but one more feasible with today’s technology.6See Gupta (1994).GovernmentThe government community feels that the funding structure for the Internet may be broken.  TheInternet has many components which are funded by the government (NSFn t, ESnet, NSI, etc.)and this funding will not go away by privatizing and commercializing just the backbone, theNSFnet.7  Therefore, the government stresses the need to be conscientious in the way differentparts of the government deploy their networks.  One of the main documents that outlines thisguidance is the Office of Management and Budget’s (OMB) Circular A-130, “Management ofFederal Information Resources.”  This circular promotes the sharing of resources between thedifferent federal agencies to save money. It also states that the costs for these information servicesshould be accounted for so that there will be an equitable sharing of the costs to provide thesenetwork services.  However, A-130 has changed recently in July of 1994 from its original 1985form in the area of cost accounting and recovery for federal networks.  The old circular states:•  “Price each services...to the users of that service on an equitable basis...”8•  “Directly distribute to the recipient of the services the full costs of...[software,hardware,] and telecommunications equipment...”9The new and revised circular states:•“For Information Processing Service Organizations (IPSOs) that have costs in excess of$5 million per year...”                                              7In fact, most of the 40,000+ networks considered to be part of the Internet are already commercial.8OMB (1985) Appendix II, section 4.c.2.9ibid. Appendix II, section 4.c.3.•“Recover the costs incurred for providing IPSO services to all service recipients on anequitable basis commensurate with the costs required to provide thoseservices...”10While the old circular was very direct about how to account and recover for costs, the newcircular is more general even though the information was moved from an appendix to the mainbody of the circular.  This change was a result of the difficult implementation of therecommendations from the original circular to shared data networks like the IP networks thefederal agencies have.  Networks like the Defense Data Network (DDN) were hurt by followingOMB A-130 too closely (as will be seen later in this paper).EconomicsThe economic community feels that the pricing structure isn’t optimal.  For a better pricingstructure, one that is more economically optimal, we could imagine a system where the priceequals the marginal cost.  However, costs in an IP network are totally fixed except for some kindof congestion cost.  This means that when a user on the Internet sends out an e-mail message orinitiates an ftp session, they are only using up bandwidth that could otherwise be used by otherusers of the network.  All of the cost associated with people, electronics, leased lines, etc. havebeen paid for already and are seen as fixed costs.Congestion, while a cost to other users, is also a deterrent for use.  For example, many Internetusers will experience high latency (delay) when they use the Internet during peak hours (i.e.business hours) and will choose to do their intensive computing some other time.  Theseapplications are fixed-delay in the sense that if the application doesn’t respond to the user withinan allotted amount of time, there is little or no value to the user.  Video conferencing, telnetsessions, etc. are examples of these applications.                                              10OMB (1994) Section 8b.4.eHowever, congestion, as a measure of marginal cost, has been the focus on the debate in theeconomic community on the subject on how to price the Internet equitably.  Proposals formapping congestion cost to a monetary cost to the user fall in two main categories, dynamicpricing and pseudo-dynamic pricing – they are defined in Appendix A.MacKie-Mason (1993) has proposed a pricing system for the Internet that falls under the categoryof dynamic pricing. Each packet sent includes a willingness-to-pay value data along with the datayou send. At the network routers, there is a "bidding" process to determine market price andqueuing order. The queue is set up such that the people who pay more for the service get higherpriority and, hence, get processed first. The people who are willing to pay nothing for theirpackets wait until there is no congestion at that router. The host who sent the packet is thencharged by packet or byte at the market price. Architecturally, this means that there needs to begreater processing at the network routers than currently exist.11 Accounting for packets sentand/or received by particular users along with their dynamic price would have to be done at therouter as well (which involves electronic storage of this data).  Finally, and perhaps most difficult,the infrastructure to bill particular users for their priority traffic by collecting money from the“owners” of IP address.12Another proposal bye Bohn (1994) et al. falls into the category of pseudo-dynamic pricing.  Theirproposal recommends that each network user pays for "chits" that allow you to send prioritypackets. You include chits in your packets by inserting them in your precedence bits in the IP                                              11Currently, routers try to minimize the amount of time necessary to process IP packets by only readingthe destination into random access memory (RAM).  If tailored queuing mechanisms were put in place,the throughput of the router decreases or the cost would go up to outfit the router with more processingpower.12This proposal doesn’t address the overhead costs to implement this system or the possibility thatsomeone may “cheat” the system by including a fake IP source address in their packets.header (3 bits). More than one chit may be used for one packet, thereby giving it a higher prioritylevel than packets with fewer chits. Therefore, eight different queues are established depending onthe precedence you pay for. All of the accounting goes on at the host computer who agrees topurchase these chits at some market price ahead of time. The billing is therefore done beforehandand not after like the MacKie-Mason proposal.  This proposal has the advantage that it could beimplemented incrementally and it is one that has been accepted before by the Internetcommunity.13EngineeringThe engineering community generally believes that the Internet is not broken since it provides anetwork for reliable applications.  If there are problem with service (e.g.  I experience large delayswhen trying to run some applications) there is no short term solution to the problem.  Althoughpeople are currently talking about bandwidth-on-demand this is very different than the method ofoperation the IP community has existed in.  The asynchronous transfer mode (ATM) communityfeels that it has solved this problem, but the technology isn’t as mature and deployed as IP today.In the long run, congestion can be mitigated by reconfiguration of the network infrastructure. Forexample, growth of the NSFnet backbone has led to a few different network architectures overthe years. The NSFnet progressed from a 56 Kbps network in 1986 to a 45 Mbps network in1994. Almost a thousand-fold increase in capacity in less than ten years. If higher capacity lineswere not added to the system, it is unclear if the Internet would be such a popular medium today.As capacity got larger with the NSFnet, a priority queuing system that had previously been inplace was abandoned.14                                              13In 1986, when the NSFnet was operating at 56 Kbps, there was very high latency.  To mitigate thisproblem, the engineers of the NSFnet decided to give priority to telnet traffic (the largest fixed-delayapplication at the time) by queuing by port number.  This didn’t use the precedence bits suggested bythe Bohn proposal.14Operating at T1 capacity (1.544 Mbps) it was no longer necessary to queue by port number.

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